Embed Size (px)
Citation preview
NORWEGIAN SCHOOL OF ECONOMICS
Bergen, Spring 2015
The use of awareness as a tool to mitigate biases
related to source credibility
-An experimental study
Idil Mahamed Abdi and Sultan Ul Arfeen
Thesis Advisor: Jonas Gaudernack
Master thesis, Regnskap og revisjon
NORWEGIAN SCHOOL OF ECONOMICS
This thesis was written as a part of the Master of Accounting and Auditing at NHH. Please
note that neither the institution nor the examiners are responsible − through the approval of
this thesis − for the theories and methods used, or results and conclusions drawn in this work.
2
Abstract:
Auditors have to rely on their professional judgment regularly while performing different
tasks in an audit. In some areas of audit the quality of their professional judgment is of very
sensitive nature and FVMs (fair value measurements) has been identified as one of them by
PCAOB (Public company accounting oversight board)
This study examines the relationship between source credibility and professional judgment of
auditors (students as surrogates) when awareness is applied as a tool to improve the judgment
quality. In Advertising and marketing previous studies have used awareness as a tool to
improve advertisement effectiveness but this study uses this tool to improve auditors’
professional judgment quality, which may contribute to the literature. This study has used
students of Norwegian School of Economics (NHH) as surrogates; it was made sure that
participating students have the necessary skills and knowledge to contribute to the study.
Data was collected from a population of 300 students who had taken intensive courses in
auditing and accounting at master’s level. The findings show that awareness has a significant
impact on professional judgment of auditors.
Key words: Source credibility, Awareness, Professional Judgment.
3
Abbreviation list:
PCAOB, Public company accounting oversight board
FVMs, Fair value measurements
JDM Judgment and decision-making
ISA International Standard on Auditing
HSM Heuristic-systematic model
NHH, Norwegian school of economics
4
Preface This thesis is part of our Master degree program MRR (Master in Accounting and Auditing)
at Norwegian School of Economics. This study is an experimental study that is carried out
with the help of Qualtrics, which is quite well known research tool. The target of our efforts
was to find out if awareness could be used as a measure to mitigate biases in professional
judgment towards source credibility in complex audit settings. We have tried to obtain
empirical evidence through an experiment, to see if awareness can reduce the auditors’
tendency of overreliance on expert valuations in areas where they lack expertise. The
experiment was carried out in May 2015 among students of MRR at Norwegian school of
Economics through Qualtrics.
We would like to pay our sincere gratitude to our supervisor, Jonas Gaudernack, for his
immense support and guidance throughout this thesis. Without his advices and personal
interest, the completion of this thesis was impossible. Special thanks also goes to all the
fellow students who participated in the study and gave their valuable support for this thesis.
Bergen , June 2015
Idil Abdi and Sultan ul Arfeen
5
Table of Contents
Abstract: ............................................................................................................................ 2
Abbreviation list: ............................................................................................................... 3
Preface .............................................................................................................................. 4
Table of Contents .............................................................................................................. 5
1. Introduction: .................................................................................................................. 8 1.1 Research objective and contribution of the study: ....................................................................................... 9 1.1.1 Judgment framing: ................................................................................................................................................ 10 1.1.2 Problem formulation: .......................................................................................................................................... 10
1.2 Research Question: .................................................................................................................................................. 11 1.3 Limitations of the study: ....................................................................................................................................... 11 1.4 Outline of the thesis: ............................................................................................................................................... 12 2. BACKGROUND & RELATED LITERAURE ......................................................................... 12 2.1 What is judgment and decision-‐making? ....................................................................................................... 13 2.1.1 Judgment and decision-‐making defined ...................................................................................................... 13 2.1.2 JDM Research .......................................................................................................................................................... 13 2.1.2 Heuristics and Biases Research ....................................................................................................................... 15 2.3.3 The Heuristic-‐Systematic model ..................................................................................................................... 15
2.2 Professional judgment defined ........................................................................................................................... 16 2.2.2 The KPMG Professional Judgment Framework ........................................................................................ 17 2.2.3 Judgment framing ................................................................................................................................................. 19
2.3 Source credibility ..................................................................................................................................................... 19 2.3.1 Source credibility in psychology ..................................................................................................................... 19 2.3.2 Source credibility in auditing (ISA 620) ...................................................................................................... 21 2.3.3 Reliance of experts in auditing: ....................................................................................................................... 22 2.3.4 Fair value measurement .................................................................................................................................... 22 2.3.5 PCAOB investigation ............................................................................................................................................ 24 2.3.6 Research findings of FVMs in auditing: ..................................................................................................... 26
3.1 Conceptual model and hypothesis .............................................................................. 27 3.2 Conceptual model ..................................................................................................................................................... 27 3. 2 Hypothesis .................................................................................................................................................................. 28
4. Methodology: .............................................................................................................. 30 4.1 Research approach: ................................................................................................................................................. 30 4.1.1 Experimental design of the study: .................................................................................................................. 30
4.2 Data type and research tool: ................................................................................................................................ 31 4.2.1 Time horizon: .......................................................................................................................................................... 31 4.2.2 Sample: ....................................................................................................................................................................... 31 4.2.3 Questionnaire: ......................................................................................................................................................... 32 4.2.4 Pre test and post experimental questions ................................................................................................... 34
4.3 Explanation of Variables ....................................................................................................................................... 34 4.3.1 Independent variables: ........................................................................................................................................ 34 4.3.2 Dependent variable: ............................................................................................................................................. 35
6
5. Statement of results .................................................................................................... 35 5.1 Manipulation checks ............................................................................................................................................... 35 5.2 Results ........................................................................................................................................................................... 36
6. Conclusion ................................................................................................................... 37 6.1 Answers to research question ............................................................................................................................ 37 6.2 Contribution to research ....................................................................................................................................... 38 6.3 Contribution to audit practice ............................................................................................................................ 38 6.4 Suggestions for future research ......................................................................................................................... 39
References ....................................................................................................................... 40
Appendix 1: Introduction ................................................................................................. 43
Appendix 2: Example of cases ........................................................................................... 44 Example for Expert*Awareness .................................................................................................................................. 44
Appendix 3: Post experimental survey .............................................................................. 48
Tables .............................................................................................................................. 50 Table 1: ................................................................................................................................................................................. 50 Table 2: ................................................................................................................................................................................. 50 Table 3: ................................................................................................................................................................................. 51 Table 4 .................................................................................................................................................................................. 52 Table 5: ................................................................................................................................................................................. 52
7
8
1. Introduction:
Professional judgment is a matter of considerable interest for both academics and
practitioners in the world of auditing and accounting services. A very decent amount of
literature has focused on the judgment and decision-making research; among this literature a
lot of papers have examined the factors, which affect the professional judgment of auditors.
Auditors and audit firms have a very key role in our current financial and economical
structure; legislating bodies, regulatory authorities, investors, shareholders and creditors, use
their reports before making important decisions.
During the process of auditing and preparation of audit reports, at many instances auditors
have to rely solely on their professional judgment. The three main areas where an auditor has
to rely on their professional judgment are evaluation of evidence, estimating probabilities and
making choices between different options. However, if professional judgment is a gift or a
skill that can be acquired through practice or knowledge has remained a focus of immense
discussion in literature.
This study has utilized the Heuristic-Systematic model towards an understanding of
possibilities of improvement in the quality of professional judgment of auditors. Previous
studies have found that ‘‘additional knowledge about common threats, together with tools
and processes for making good judgments, can improve the professional judgment abilities of
both new and seasoned professionals’’ (Eilifsen, Messier, Glover, & Prawitt, 2014)
Previous experimental studies on professional judgment have mainly focused on explaining
the process of decision-making or identification of the factors that affect this process. Some
parts have been focusing on improving the professional judgment quality of auditors. The
Public Company Accounting Oversight Board (PCAOB) has shown concerns about auditing
deficiencies and impairments in auditor’s professional judgments especially regarding fair
value measurements (PCAOB 2011). Because of this current relevance to the auditing world
this study has chosen FVMs as part of the experimental investigation.
9
Can professional judgment towards fair value measurements be improved somehow? One of
the most important footsteps towards avoiding judgment traps and diminishing bias produced
by subconscious mental shortcuts is what is termed as “Awareness”. By a better
understanding of traps and biases, and recognizing common situations where they are likely
to present themselves, we can identify potential problems and often formulate logical steps to
improve our judgment.
The purpose of this study is to determine if awareness can be used as a tool to improve the
professional judgment of auditors specially while evaluating authenticity of FVMs provided
through two different sources i.e. independent valuation specialists and in house managers.
1.1 Research objective and contribution of the study:
The main objective of this study is to contribute to the discussion in the auditing world about
improving professional judgment, specifically regarding complex accounting estimates where
auditors have to rely on the works of others. Auditing standards require auditors to perform
procedures to obtain evidence supporting expert’s opinion. However in reality research
suggests that auditors over rely on third part expert opinion especially in areas where auditors
lack expertise and experience. This study looks at how this bias can be mitigated?
This study is going to perform an experimental investigation of one of the possible factors,
which can help auditors improve their professional judgment in situations where there is
maximum risk of overreliance and blind trust on expert´s work. By observing how awareness
moderates the relationship between source credibility and professional judgment, this study
can contribute to the efforts of improving judgment quality in areas that are on the top of
PCAOBs concerns list.
10
1.1.1 Judgment framing:
This study assumes a judgment setting where the auditors or judges are exposed to fair value
measurements (FVMs) and are asked to assess inherent risk on a given scale from 1 to 7.
Subjects will be divided into three treatment conditions: Expert, In-house and Expert with
awareness. In regards to subjects in the third-party expert condition, Half of participants are
made aware about what can possibly go wrong and the other half were free to make their
judgments in normal manner.
1.1.2 Problem formulation:
Unfortunately this study is not taking into account all the factors, which can affect the
professional judgment of auditors. For the purpose of this study we have taken PCAOBs
concern list as a guideline and identified professional judgment quality towards source
credibility of FVMs as an area of interest.
PCAOB has identified fair value measurement (FVM) as an area with huge increase in audit
deficiencies. This is related to the measurement of certain assets especially the price
determination of complex financial instruments. Fair value measurements and impairment
audit shortcomings are specifically significant as these two specific issues are responsible for
more than half of all latest audit deficiencies (PCAOB 2011).
In order to contribute to the discussion we have focused on collecting and analyzing
empirical evidence pertaining to the moderating role of awareness, in a setting where
professional judgment quality towards source credibility is evaluated. For the study we have
considered the inherent risk assessment as proxy for professional judgment quality. PCAOBs
reports are very clear about source of FVMs i.e. 3rd party evaluation experts but we have
added an additional dimension of in-house prepared FVMs as well to observe variations in
both cases.
11
Despite the importance of this issue, there is only limited empirical evidence available
relating to factors which can act as a catalyst to improve judgment quality in complex audit
settings. This thesis aims on contributing to the literature by examining the impact of the
awareness on mitigating judgment biases and improving professional judgment quality in
settings where auditors lack expertise and experience. It will be interesting to see whether and
how the relationship between source credibility and professional judgment quality differs
after the introduction of a tool called awareness, which has successfully been used in other
socio-psychological research studies to improve behavioral judgments.
Based on the above narrative we have arrived at the following research question
1.2 Research Question:
Can awareness be used as tool to help mitigate biases related to source credibility?
1.3 Limitations of the study:
Unfortunately due to the time constraint and the limited resources available it was not
feasible to access practicing auditors as subjects for the study. The data have been collected
from the NHH students who are studying auditing and accounting at an advanced level and
have all the necessary skills and knowledge required to take part in the study. The use of
students as surrogates has been supported by previous research where students and business
professionals made very similar judgments in decision-making studies (Ashton and Kramer
1980).
This study is a cross sectional study and the data is collected over a time period of 7 days.
Data is collected only from the students of NHH who have gone through the courses, which
provide essential knowledge base and skills required for taking part in the study. So if any
other researcher uses different set of subjects i.e. auditors with many years of experience and
longitudinal data he or she may arrive at different results.
12
The study is limited to few variables i.e. source credibility, professional judgment and
awareness. Hence results cannot be applied to all the situations where one of the given
variables is present but others are changed. Awareness can exhibit a different role in a
situation where there are many independent variables and dependent variables.
1.4 Outline of the thesis:
The rest of the thesis is organized as follows: Section two is an overview of related theories
and judgment and decision making literature relevant to the study. Section three further
develops the conceptual model and proposes the hypotheses for the study. Section four
describes the experimental design, sample, questionnaire and pretesting of the data collection
instrument.. Section five is a description of the statistical results from the data collected.
Section six is the final part of the study, which includes our conclusion and a discussion
about limitations, implications and suggestions for future research.
2. BACKGROUND & RELATED LITERAURE
This chapter serves as a backdrop for the empirical section and a foundation for discussion
and analysis throughout this thesis. This thesis is rooted in the area of judgment and decision-
making, therefore we will briefly define judgment and decision-making (JDM). We will also
include previous JDM research in accounting and auditing. Second, we will define and
summarize heuristics and biases research, which is our topic of choice in JDM research.
Third, we will define and discuss both professional judgment and source credibility.
13
2.1 What is judgment and decision-making?
2.1.1 Judgment and decision-making defined
The term judgment refers to “forming an idea, opinion, or estimate about an object, an event,
a state, or another type of phenomenon (Bonner, 1999, p. 385). In the dictionary the term
decision is defined as a “choice made between alternative courses of action in a situation of
uncertainty” The two terms are interlinked, it is said that generally decisions usually follow
judgments, meaning that judgment usually refers to the process of estimating outcomes and
their consequences…while decision-making involves an evaluation of these consequences
which leads to a choice among the alternatives ( (Trotman, Tan, & Ang, 2011, p. 279)
In auditing and accounting, judgment occurs in three areas.
1. Evaluation of evidence: e.g. assessing when a sufficient amount of appropriate
evidence has been obtained in order to determine the fairness of management´s
assertions.
2. Estimating probabilities: e.g. determining whether the probability-weighted cash
flows used by a company to determine the recoverability of long-lived assets are
reasonable.
3. Deciding between options: e.g. deciding between audit procedures to determine if
specific audit assertions are being met.
2.1.2 JDM Research
Since the mid 1970´s accounting and auditing researchers have focused more and more on
understanding individual and group judgments and decisions. The first study to
systematically examine auditor´s judgments was Ashton in 1974. Ashton´s research
examined experienced auditors judge the strength of a hypothetical client’s internal controls
14
in the payroll system based on six cues. Since then, thousands and thousands of JDM studies
have surfaced.
The aim of JDM research is to be descriptive, prescriptive and normative. This means that
JDM research in auditing; JDM research is intended to “describe how and how well auditors
make audit decisions and improving the judgments of auditors, preparers and users of
accounting information” (Trotman, Tan, & Ang, 2011, p. 279)
JDM research is often called experimental psychology, the reason for that is that the most
common method of understanding auditor judgments is through the use of experiments.
The main benefits of experiments are that the researcher creates the setting for the
experiment, manipulates the independent variables of choice, and examines the effect on
dependent variable while controlling the effect of any confounding variables. Experimental
design has an advantage that it can study the conditions, which either don’t exist or exist in an
insufficient volume or magnitude. Experimental design allows strong interferences to be
made and studied (Trotman, Tan et al. 2011). Research about JDM can then be defined as
research that focuses on factors of judgment and decisions as either dependent or independent
variables.
But why is judgment and decision-making in auditing so important and why should we bother
to studying it? Well there are both practical and theoretical reasons for studying JDM. From
a practical perspective financial statement audits have a very critical role for our economy
and important decisions depend on the results of such audits. Accounting at its core is about
the judgment and decision-making (JDM) of individuals such as investors, managers, and
auditors.
15
2.1.2 Heuristics and Biases Research
During the late 1970´s Amos Tversky and Daniel Kahneman developed a theory that
reformed JDM research, as a summarization this theory states that in general “people rely on
a limited number of heuristic principles which reduce the complex tasks of assessing
probabilities and predicting values to simpler judgmental operations" (Tversky &
Kahneman, 1974, p. 1124).
As we´ve referenced before the purpose of JDM research is to understand puzzling human
judgment and behavior. Kahneman and Tveraky's research has sparked a flame in the world
of psychology, since the 1970´s more and more researchers have adapted and applied
Kahneman and Tveraky's theory. The popularity hasn’t stopped with just psychology the
writer McKean states that “Kahneman and Tveraky's research has resulted in a theory that
provides a systematic explanation for some of the most puzzling aspects of human behavior,
and spearheaded the growth of a new discipline of science devoted to the behavioral aspects
of decision making.. Kahneman and Tveraky’s work has begun to attract the attention of a
wider audience such as doctors, lawyers, businessmen, and politicians, who see applications
for it in choosing therapies, devising legal arguments and corporate strategies, even
conducting foreign affairs." (McKean, 1985, p. 23)
As a result of this growing popularity, behavioral auditing researchers have developed an
interest in cognitive heuristics and biases.
Ashton (1983, p.34) concluded that, "the research on heuristics and biases in audit decision-
making has been somewhat limited and the results have been mixed”.
2.3.3 The Heuristic-Systematic model
The Heuristic-Systematic model was developed in 1980 by a social physiologist named
Shelly Chaiken. The model attempts to explain how individuals receive and process
persuasive messages.
16
Based on Chaiken’s model, there are two ways of processing a message, a heuristic approach
and a systematic approach. “Heuristic processing involves the use of judgmental rules known
as knowledge structures that are learned and stored in memory” (Chen, Duckworth, &
Chaiken, 1990). For example, people might have learned that messages from experts are
more valid, then those with less expertise. Or that people might agree more with long and
detailed arguments.
According to a systematic view, individuals exerts more cognitive efforts when processing
information, they evaluate the true merits of the information provided. “Judgment formed on
the basis of a systematic processing involves a relatively in-depth treatment of judgment-
relevant information” (Chen, Duckworth, & Chaiken, 1990).
Both heuristic and systematic processing can co-occur. Chaiken and Maheswaran (1994)
conducted a study, which showed that “source credibility affects the decision makers’
perception of the persuasion of the information through its impact on the importance of
systematic processing” (Chaiken & Maheswaran, 1994). This means that heuristics can effect
systematic processing.
This study adapts the Heuristic-Systematic model to understand the underlying influences of
professional judgment in order to effectively identify how to improve the quality of
professional judgment of auditors.
2.2 Professional judgment defined
Professional judgment is a requirement in so many fields, like the government, the legal
system or medicine. Basically any work environment where professionals need to make
important daily decisions.
According to the International Standard on Auditing 200 (ISA 200), professional judgment is
defined as “the application of relevant training, knowledge and experience, within the
17
context provided by auditing, accounting and ethical standards, in making informed
decisions about the courses of action that are appropriate in the circumstances of the audit
engagement”.
As an accounting and auditing student, you often find your instructor referring to
professional judgment as answers to auditing questions. In fact many auditing task require
decisions based on professional judgment and seeing that auditors are held liable for their
decisions, it is therefore important to understand the mechanics of good judgment.
Some believe that good judgment is a gift, either you have it or you don’t. Others believe that
good judgment is a skill that can be learned and improved with knowledge and practice.
Previous studies indicate that “additional knowledge about common threats, together with
tools and processes for making good judgments, can improve the professional judgment
abilities of both new and seasoned professionals” (Eilifsen, Messier, Glover, & Prawitt,
2014).
So based on previous studies, there seems to be hope for accountant and auditors to
develop/improve good professional judgment. Therefore KPMG has developed a monograph
that will help understand the underlying causes of good judgment in order to improve the
professional judgment of auditors. The monograph is titled Elevating Professional Judgment
in Auditing and Accounting: The KPMG Professional Judgment Framework. The contents of
this monograph sparked the initial idea for this thesis.
2.2.2 The KPMG Professional Judgment Framework
The monograph includes KPMG´s professional judgment framework. This framework was
developed to help auditors navigate through complex and uncertain tasks.
18
Figure 1.of KPMG´s professional judgment framework. Adapted from “Elevating Professional
Judgment in Auditing and Accounting: The KPMG Professional Judgment Framework” by
(Chevalier, Glover , Herrman, Prawitt, & Ranzilla, 2013)
The figure above depicts components that are fundamental to quality judgment, such as
consultation, knowledge and professional standards, influences and biases, reflection,
coaching and at the core of this framework is auditor´s “mindset”. This means that auditors
should approach matters objectively and independently, with a questioning mind, in other
words auditors must apply professional skepticism. Professional skepticism is an important
component of professional judgment.
Surrounding the mindset, there is a five-step judgment process. These steps will help prevent
judgment traps caused by self-interest or by unknowingly applying mental shortcuts.
The most important step in avoiding judgment traps and reducing bias caused by
subconscious mental shortcuts. This term is called “awareness.” Meaning by “better
19
understanding traps and biases, and recognizing common situations where they are likely to
present themselves, we can identify potential problems and often formulate logical steps to
improve our judgment” (Chevalier, Glover , Herrman, Prawitt, & Ranzilla, 2013, p. 33)
Awareness enables auditors to evaluate the true merits and also helps to avoid judgment
traps. Of course, this takes practice and experience. But when auditors are armed with
awareness and understanding of these traps and biases, they can improve the quality of their
professional judgments.
2.2.3 Judgment framing
This concept relates to the early steps in the judgment process. The definition of framing
follows: “Frames are mental structures that we use, usually subconsciously, to simplify,
organize, and guide our understanding of a situation” (Chevalier, Glover , Herrman, Prawitt,
& Ranzilla, 2013). One cognitive research that we believe support this concept is the heuristic
systematic model of information processing.
2.3 Source credibility
2.3.1 Source credibility in psychology
Source credibility is a” term commonly used to imply a communicator's positive
characteristics that affect the receiver's acceptance of a message” (Ohanion, 1990). The
source credibility theory is an established theory that was first studied by Carl I. Hovland and
Walter Weiss in the early 1950´s. The theory states that individuals are more likely to be
persuaded if the communicator is perceived as an expert, trustworthy or credible. In a sense
this means that “the effectiveness of the communication is dependent on the attitude of the
audience towards the communicator” (Hovland & Weiss, 1951).
In 1961 Helbert Kelman built on Howland and Weiss´ theory and proposed a theoretical
framework that could explain what characteristics would affect the receiver's acceptance of a
message. (Kelman, 1961) narrowed it down to three characteristics.
20
• Internalization: Which occurs when the individual accepts a message that is
congruent with his/her own value system. Meaning if the individual finds the
communicator trustworthy or an expert, he/she may be more persuade to accept the
message.
• Identification: Individuals may adopt the behaviors/attitudes of others because they
whish to establish/maintain a relationship with a desired group of people/ individuals.
A common example is attractive sources compared to unattractive sources
• Compliance: Occurs when individuals accepts a message in hopes of self gain, this
could include some type of reward. Compliance also occurs if the individual accepts
a message in fear of a specific punishment.
As a result of Kelman´s framework, each of the three characteristics have been research in
later years. However there is limited research on compliance, since both reward and
punishment must be studied. Researches have had a hard time establishing mundane/realistic
rewards and punishments.
In 1978 Sternthal, Phillips, and Dholakia researched if a communicator´s characteristic could
affect the persuasiveness of a message. Specifically they studied source credibility, where
they indicated that statements from an expert source had an effect on the acceptance/rejection
of a message.
Joshua L. Wiener and John C. Mowen conducted a 2 x 3 between subjects factorial
experiment in 1986. They used source expertise and trustworthiness as manipulators. Wiener
and Mowen concluded that the experiment should that source´s message is affected by
trustworthy and/or expert sources. They also found that the level of expertise of the source
strongly influenced the participants’ perceptions
21
2.3.2 Source credibility in auditing (ISA 620)
“The essence of a financial audit is to search for and evaluation of evidence regarding the
accuracy of management´s assertions” (AICPA 1980; Goodwin 1999; AICPA 2006a).
Sources for such evidences can be credible third parties such as lawyers, valuation experts
and internal auditors. It is very common for external auditors to use the works of others, and
in most cases this allows for the external auditor to reduce their planned auditing hours.
By using the work of others the external auditor must keep in mind that he/she is solely
responsible for the audit opinion expressed. This means that the auditor must be mindful of
what he/she deems as appropriate audit evidence. The ISA (International Standard on
Auditing) 620 deals with “the auditor’s responsibilities relating to the work of an individual
or organization in a field of expertise other than accounting or auditing and when that work
is used to assist the auditor in obtaining sufficient appropriate audit evidence” (ISA 620).
The standard explains that it is the auditor´s job to determine whether there is a need to use
the work of an expert. If the auditor determines to use the work of others, then the auditor
must have an appropriate understanding of that field of expertise. Meaning that the auditor
must be able to evaluate the adequacy of that work.
In ISA 620 there are three main factors to determine the adequacy of an experts work. First
there is competence, which “relates to the nature and level of expertise of the auditor’s
expert”. Secondly there is capability, which relates to “the ability of the auditor’s expert to
exercise that competence in the circumstances of the engagement. Factors that influence
capability may include… the availability of time and resources”. Objectivity relates to the
possible “effects that bias, conflict of interest, or the influence of others may have on the
professional or business judgment of the auditor’s expert”.
22
Also the auditor should not overlie on the work of an expert and it is suggested that auditors
should perform procedures to obtain evidence to support the expert’s work. However in
practice there’s some evidence that show that auditors tend to overly on expert opinions.
Especially when the work is conducted in an area that the auditor lacks in expertise.
2.3.3 Reliance of experts in auditing:
In 2009 Jennifer Blaskovich and Natalia Mintchik, investigated how external auditors
perceive the involvement of external consultants. This study explained that since the
Sarbanes-Oxley Act of 2002, firms stated to use internal control consultant (IC consultant), to
help with compliance of accounting regulation and to guard against unexpected surprises
during the external audit. (Blaskovich & Mintchik, 2009)
Blaskovich and Mintchik hypothesis that the presence of such consultants would lead to
higher reliance on internal controls and lower budgeted audit hours. However they
manipulated management´s credibility and therefore also stated that auditor´s reliance on
internal control would be affect by the varying levels of management´s credibility.
Blaskovich and Mintchik´s experiment showed that “the involvement of the IC consultant
significantly impacts auditors’ planning decisions. Specifically, when a low credibility client
engaged an IC consultant, the auditors assessed a higher reliance on internal controls and
budgeted fewer audit hours, relative to the no consultant situation” (Blaskovich & Mintchik,
2009).
2.3.4 Fair value measurement
Recently the use of valuation specialist has been the area of investigation for the Public
Company Accounting Oversight Board (PCAOB). Especially pertaining to fair value
measurements. Auditors must have a good understanding of the accounting and auditing
frameworks associated with FMVs, however it is common for auditors to use a valuation
23
expert. It is not expected that all auditors are experts in the area of valuation, particularly
since the valuation of FVMs can be complex and judgment-based.
IFRS 13 established a framework for measuring fair value. According to IFRS 13 fair value is
defined as “the price that would be received to sell an asset or paid to transfer a liability in
an orderly transaction between market participants at the measurement date”. However
because orderly transaction between market participants may or may not be observable at
measurement date, IFRS 13 provides a hierarchy with three levels that are used to distinguish
the types of inputs used to value different types of assets and liabilities at their appropriate
fair values.
I. Level 1 inputs are quoted prices in active markets for identical assets or
liabilities that the entity can access at the measurement date.
II. Level 2 inputs are inputs other than quoted market prices 1 that are
observable for the asset or liability, either directly or indirectly. Level 2 inputs
include: quoted prices for similar assets or liabilities in active markets or
quoted prices for identical or similar assets/liabilities in markets that are not
active
III. Level 3 inputs are unobservable inputs for the asset or liability. Unobservable
inputs are used to measure fair value to the extent that relevant observable
inputs are not available, thereby allowing for situations in which there is little,
if any, market activity for the asset or liability at the measurement date. An
entity develops unobservable inputs using the best information available in the
circumstances, which might include the entity's own data, taking into account
all information about market participant assumptions that is reasonably
available
24
2.3.5 PCAOB investigation
PCAOB (Public company accounting oversight board) is an organization established by
Congress to examine the audits of public companies to make sure that interests of investors
are protected along with the public interest in the preparation of audit reports in an accurate
and independent manner.
The PCAOB keeps an oversight on public accounting firms in light of Sarbanes-Oxley Act of
2002. The inspections are tailor made to detect deficiencies in audit engagements and to
identify the shortcomings as either weakness or defect in the system of quality control put in
place by the firm. The PCAOB carries out annual inspections for over 100 issuers of audit
reports and Big 4 are among the firms that get inspected annually.
Audit Deficiency Trends
The PCAOBs reports from 2008 through 2012 indicate different trends. The ratio of deficient
audit engagements has increased manifolds since 2009. In current scenario almost one out of
three audits carries significant level of deficiencies. In 2012 yearly inspections, PCAOB
identified deficiencies in 42.5% of audits along with other related engagements; in 2009 this
percentage was 16.0% of the audits inspected.
PCAOB has identified fair value impairment (FVM) as an area with huge increase in audit
deficiencies related to the measurement of certain assets specially the price determination of
complex financial instruments.
The above-mentioned increase in audit deficiencies follows the pattern of a general increase
in overall audit deficiencies, and can be a consequence of uncertainty generated by economic
slump. Fair value measurements and impairment audit shortcomings are specifically
significant as these two specific issues explain for more than half of all latest audit
deficiencies.
25
Auditing the assessments and estimates fundamental to FVM and impairments requires
amplified professional skepticism because these judgmental areas are vulnerable to bias from
the management, special in time of economic challenges.
Third party evaluations specific concern:
The PCAOB reports have identified that FVM audit deficiencies mainly originated from
insufficient examination of asset prices provided by outside or 3rd party pricing services, and
pointed out a number of deficiencies about auditors’ over reliance on evidence collected from
the specialists. It includes failure to understand the methods, the models used by the experts,
and the assumptions underlying the valuation.
One of such complex FVMs are particularly level 3 FMVs with high degree of subjectivity in
nature. PCAOBs recent criticism was about public accounting firms for their failure to ensure
proper procedures, relying on insufficient evidence, and inappropriate confidence on the
specialists for FVMs. In 2012 the PCAOB took it even more seriously and decided to include
the FVMs to the list of priorities of PCAOB.
26
2.3.6 Research findings of FVMs in auditing:
After the release of PCAOB´s inspection report, more researchers have conducted studies
investigating auditors’ judgments about accounting estimates. Brian Bratten, Lisa Milici
Gaynor, Linda McDaniel, Norma R. Montague and Gregory E. Sierra conducted the most
recent review of those studies in 2013.
Bratten, Gaynor, McDaniel, Montague, and Sierra (Bratten et al 2013) used Bonner´s
theoretical framework and organized their review into three categories, environmental,
personal and task. In the environmental section of this review they discussed the use of
external valuation specialists. Auditors do use pricing services, but a review of surveys
conducted showed that auditors do not believe that the use of pricing services can cause…
Bratten et all also indicated that there is a lack of empirical research, that studies the effect of
using pricing services on audit quality or perceived audit quality is lacking.
Steven M. Glover, Mark H. Taylor and Yi-Jing Wu (2014) conducted a survey to gather data
that the possible causes of the FVM expectation gap (a concept describing the differences in
what auditors and regulators consider “enough” evidence to support audits of FVMs) Glover,
Taylor and Wu surveyed 32 audit partners from five audit firms that were annually inspected
by the PCAOB. All 32 participants had experience with planning, supervising and executing
FVM audits.
Results of the survey showed 60 percent of participants suggested that the current
requirement to provide a high level of assurance that a point estimate is fairly stated within
auditor materiality be reconsidered because providing such assurance on point estimates is
unrealistic and potentially misleading given the level of subjectivity, complexity and
uncertainty. Nearly all participants (93 percent) supported the idea of revising auditing
standards to provide additional clarity and guidance around estimates characterized by
extreme measurement uncertainty (Glover, Taylor, & Wu, 2014, p. 4)
27
Emily E. Griffith, Jacqueline S. Hammersley and Kathryn Kadous interviewed 24 auditors
that all have sustainable experiences with complex accounting estimates. The main objective
of this survey was to understand the process of auditing complex accounting estimate. The
study also provided an understanding to the problems associated with this task, and also the
underlying reason for those problems.
Griffith, Hammersley and Kadous (2012) found out that an “overwhelming” amount of
auditors would test the management´s valuation process for complex estimates rather than
using an approach that relies less on management´s assertion. Griffith, Hammersley and
Kadous concluded that based on this observation this indicates “an overreliance on
management assertions, and such overreliance is corroborated by our analysis of PCAOB
inspection reports. That is, auditors sometimes fail to adequately test assumptions and data
underlying the estimation model, fail to consider controls over management’s process and
the data, and fail to fully understand the model “ (Griffith, Hammersley & Kadous , 2012)
There is a lack of empirical studies conducted as a result of PCAOB´s investigation. However
we have found the results of one particular working paper interesting. In 2014 Liburd, Mason
and Shelton examined the effect of third-party specialists and internal control effectiveness
on auditors’ assessment of risk related to auditing FVMs.
3.1 Conceptual model and hypothesis
3.2 Conceptual model
Based on Bratten et all 2013 there is a need for empirical research that studies the use of
third-party valuation specialists and factors that affect auditors’ risk assessments around
FVMs. This study examines the effect of awareness on auditors risk assessments.
28
Prior research shows an overreliance on external valuation specialist, especially complex
accounting estimates where the auditor is lacking in expertise. As stated in the KPMG
framework, there are different components that make up professional judgment, one of those
components is the biases and influences that affect an auditors professional judgment.
Liburd, Mason and Shelton found that source credibility (heuristic processing) affected
auditors risk assessment of complex FVMs. Following the HSM theory, this study examines
if awareness can affect the direction and/or strength of the relation between source credibility
and professional judgment.
3. 2 Hypothesis
This study aims to test the interaction effect of awareness on source credibility and professional
judgment. The following 2 hypotheses predict the outcome of this study.
Independent Variable: Source credibility
Dependent Variable: Professional judgment
Moderating variable: Awareness
29
Awareness ON Awareness OFF
Third-party specialist
Treatment 1= H1 Treatment 2= H2
In house manager N/A Treatment 3= H1
H1: If third-party valuation specialists provide fair value measurements and
participants are aware of PCAOB concerns, then they will assess a higher inherent risk,
than those without the PCAOB´s concerns list.
H0: Awareness has no effect on inherent risk when third-party specialist provides fair
value measurements.
H2: If a third-party valuation specialist provides fair value measurements then
participants will assess a lower inherent risk, than those provided by in-house
managers.
H0: Source cues will not have an effect on inherent risk
We believe that if individuals are provided with an understanding of the increase FVM
deficiencies, this will cause them to be more skeptics and question the credibility of the third-
part provider. By engage in a greater extent of systematic processing, participants will
evaluate the true merits of the information provided and will assess a higher inherent risk,
then those without the PCAOB´s concerns list.
A hypothesis for in-house manager with PCAOB concern list is not provided, because this
thesis aims to study the use of awareness as a tool to mitigate the biases of source credibility.
30
In summary inherent risk is predicted to be highest in treatment3 and treatment 1 will have
the lowest inherent risk. Awareness is used in H2 in order to reduce the gap between
treatment 1 and 2.
4. Methodology:
4.1 Research approach:
The focus of this master thesis is judgment and decision-making (JDM) in auditing. Judgment
and decision making research is taken up to understand judgments and decisions of
individuals and groups. Those who make these judgments include auditors, preparers of
financial statements, and users like investors, analysts, bankers who make judgments and
decisions regarding investments and lending. JDM research includes evaluating the quality of
judgments made by the above-mentioned actors, explaining the process of decision-making,
identification of the factors that affect this process, and improving the judgment quality of
auditors, users and preparers of financial statements (Trotman, Tan et al. 2011).
The purpose of this study is to determine if awareness can be used as a tool to improve the
professional judgment of auditors specially while evaluating authenticity of FVMs provided
through two different sources i.e. independent valuation specialists and in house managers.
Our research design uses the experimental method and quantitative data is collected to
support our theory and hypotheses.
4.1.1 Experimental design of the study:
This study is going to perform a factorial experimental to investigation if awareness can help
auditors improve their professional judgment in situations where there is maximum risk of
overreliance and blind trust on expert´s work.
31
A factorial design suits best in our study because we want to study how source cues and
awareness can affect professional judgment. A factorial design will help us study both main
effects and interaction effects.
Our experiment allocated subjects randomly to a 2 (source: third-party/in-house) x 2
(Awareness: Off/On) between subjects factorial design. However since we are interested in
predicting the use of awareness to mitigate biases related to source credibility, we have
omitted to use awareness on in-house management condition. Instead we use the in-house
condition to observe variations between source cues.
Therefore we have reduced it to three treatment conditions:
• Third-party specialist with awareness
• Third-party specialist without awareness
• In-house management without awareness
4.2 Data type and research tool:
We used primary data for this study. We used questionnaire for collecting the data, which
provided us with better control over sample structure and suitability of the data collected. We
choose to use questionnaires because of economical cost and greater/easier access to subjects
in minimum possible time.
4.2.1 Time horizon:
Considering the limited resources and time available at disposal our study is a cross-sectional
study. We collected the data through questionnaires over a time period of a week.
4.2.2 Sample:
Our experiment is based on the data collected from eligible participants who had the ability
and necessary skills to answer the questionnaire. In such situation a non-probability sampling
was more practical than probability sampling. So we chose convenience-sampling technique
to access the subjects who are familiar to the task in questionnaire.
32
We have chosen students of NHH who are studying auditing and accounting at an advanced
level. All of them have taken an intensive course in auditing in 1st semester at masters level,
they have necessary skills to take part in the research and have performed similar tasks as part
of their auditing course MRR 411. Due to time constraint and other practical reasons like
access to the practicing auditors it was not possible to engage auditors with many years of
professional experience.
The use of students as subjects is very common in accounting research and other behavioral
sciences. Past results of research in accounting decision-making provides evidence that
students as surrogates and business professionals made very similar judgments and shared
common reasoning for their decisions. (Ashton and Kramer 1980) argues that students are an
acceptable choice for decision-making research in accounting.
4.2.3 Questionnaire:
Our study is a cross sectional study, so it is very important that the questionnaire we use for
collecting the data answers all the questions important for our study. Our questionnaire is
adopted from the study of (BROWN LIBURD 2014) . However we added some
modifications that were necessary to make it suitable for our research. We removed all
internal control information that was provided in the original case, since information about
internal controls is not necessary for assessment of inherent risk. We also altered the
description of in-house management expertise, previous description showed too much
similarity to third-party specialist.
We created and conducted the questionnaire through a well-known research instrument called
Qualtrics because Qualtrics makes it easy for the subjects to respond online and helps us to
collect and transfer the data to statistical analysis software efficiently. Qualtrics helped us
distributing the questionnaires randomly and subjects were exposed to one of the three
experimental conditions.
33
4.2.3.1 Questionnaire Design:
Our questionnaire consists of a total of 3 to 4questions and all of them are closed ended
questions. We selected closed ended questions because they are simple to interpret and
responses are easier to use in a data analysis. The two main questions are rating questions
using the traditional Likert Scale. We have used a seven-value scale for assessment of
inherent risk and source credibility. The two dichotomous questions were used for
manipulation checks with only two answers True/False. The questionnaire is presented in the
appendix.
4.2.3.2 Questionnaire description:
The questionnaire starts with the description of the task, which is followed by the description
of the company and its assets, which are the focus of our study. The subjects are informed
that this study is part of our Master thesis. In the introduction of the questionnaire subjects
are encouraged to answer and it is told that it will not more than 5-7 minutes and requested to
answer to the best of their capabilities.
Our questionnaire can be divided in to 3 main parts; it starts with the description of the task,
facts about the company, source of evaluations and the questions section. One out of three
types of questionnaires have an extra part related to awareness manipulation. All the
respondents are randomly assigned one of the three treatments.
There are three questionnaires used in the experiment according to the experimental research
design applied:
Questionnaire 1:
Questionnaire 1 is the experiment condition where subjects are exposed to 3rd party prepared
FVMs and awareness treatment is on as well. The questionnaire begins with a short
34
paragraph about the PCAOBs concern about the FVMs preparations and Auditors pattern of
professional judgment.
Questionnaire 2:
Questionnaire 2 is the experiment condition where the subjects are exposed to 3rd part
prepared FVMs but awareness treatment is off here so there is no information about PCAOBs
concerns.
Questionnaire 3:
Questionnaire 3 represents the experimental condition where subjects are provided with in-
house prepared FVMs and no awareness treatment is applied, which means subjects are not
informed about PCAOBs concerns about FVM preparation.
4.2.4 Pre test and post experimental questions
The questionnaire and post experimental survey was pre-tested on six participants. Two
participants were used in each treatment condition. The post experimental survey is
presented in appendix 3.
4.3 Explanation of Variables
4.3.1 Independent variables:
In our experimental study there are two independent variables, which are operationalized as
two independent factors in the experimental factorial design. These two factors are source
credibility and awareness; source credibility has two levels and awareness as one level.
Source credibility is the critical independent variable here and its role is discussed in the
theoretical framework in the light of previous literature. In the early phase of our study we
were taking awareness just as an independent variable but in the later phase of the study our
35
interest developed in how awareness plays a role of moderating the relationship between
source credibility and professional judgment. Since then our study focused on studying the
interaction effect of awareness in the experimental design.
According to (Baron 1986) moderator is in general terms a variable which can be either
qualitative or quantitative and it affects the direction and strength of the causal relationship
between independent and dependent variables. So this experimental design can help us
finding out if awareness can improve auditor’s judgment when there are fair chances of
existence of bias towards source credibility.
4.3.2 Dependent variable:
We are using auditor’s professional judgment as dependent variable in our study and
evidence of using professional judgment as dependent variable in recent studies is the
research done by (Siddhartha Sankar Saha 2015) on studying the effects of engagement
issues on professional judgment. The dependent variable is operationalized through the
inherent risk assessment process where auditors perform an assessment of inherent risk
5. Statement of results
5.1 Manipulation checks In order to determine if participants realized the source condition of the experiment, we asked
participants the following statement:
• Expert cue: True or false, in developing fair value measurement and disclosures,
Paladin Capital Group uses the services of an independent third-party valuation firm.
• In-house management cue: True or false, in developing fair value measurement and
disclosures, Paladin Capital Group uses the services of a manager from within the
firm.
36
All participants correctly identified the source cue presented to them. In addition participants
were asked to also rate the credibility of those preforming the valuation for FVMs. Graphs
1,2 and 3 show the results of those ratings.
Providing participants with a summary of PCAOB´s findings operationalized awareness. We
asked participants if this summary had an effect on participants inherent risk assessment. All
12 participants agreed that the summary had an effect on their assessment.
5.2 Results
Descriptive statistics:
Awareness ON Awareness OFF
Third-party specialist
3.75
(0.621)
2
(0.774)
In house manager N/A 4.93
(0.730) Note: Participants’ assessment of inherent risk and was measured on a scale of 1 – 7 where
1=low risk; 4 = moderate risk; and 7 = high risk. Standard deviations are in parenthesis.
Mean comparisons are generally consistent with our expectations.
To investigate whether either of the two independent variables or their interaction are
statistically significant, we preformed ANOVAs using participants’ assessments of inherent
risks. This is shown in the “Tests of Between-Subjects Effects” in table 3.
The main effect of source cue on inherent risk was significant such that FVMs provided by
third part received a lower rate of risk than the ratings of those provided by management, (F
(1,34) = 104.564, p < .0001). Also the main effect of awareness manipulation was significant
(F (1,34) = 34.787, p < .0001).
37
Testing of hypothesis:
To test the two hypotheses, we used a two-tailed correlation test. Table 4 and 5 show the
results of those test. To summarize there is a significant relationship between “expert” and
“expert with awareness “because our p-value is less then 0.05. Therefore we can reject the
null hypothesis for H1.
There is also a significant relationship between the two different source cues, “expert and in-
house”. P test is at 0.006 and is less then 0.05. Therefore we can reject the null hypothesis
for H2. All tested hypothesis were supported at the 0.01 level.
Awareness ON Awareness OFF
Third-party specialist
H1
Supported
H2
Supported
In house manager N/A H2
Supported
6. Conclusion
6.1 Answers to research question
RQ1: Can awareness be used as tool to help mitigate biases related to source
credibility?
The aim of this study was to see of professional judgment towards fair value measurements
could be improved somehow. Our theory suggested that participants would perceive third
38
party specialist as more credible then in-house management and that this would be caused by
subconscious mental shortcuts.
We hypothesized that if participants were informed of the consequences that lead to judgment
traps and bias, participants would try to diminish the effect produced by subconscious mental
shortcuts.
Using a 2 x 2 experimental design, we asked 37 auditing students to make an inherent risk
assessment involving FVMs, Results showed that auditors assessment of inherent risk as
lower for when the client uses a third-party valuation specialist. Inherent risk was highest
when the client used in-house management. We used awareness as a moderator and found
out that participants were significantly affected by the PCAOB concerns list.
6.2 Contribution to research Bratten et all 2013 indicated that there is a lack of empirical research, that studies the effect
of using external pricing services on audit quality or perceived audit quality.
This study hopes to contribute to this discussion. Therefore we have focused on collecting
and analyzing empirical evidence pertaining to the moderating role of awareness, in a setting
where professional judgment quality towards source credibility is evaluated.
6.3 Contribution to audit practice
This study has implications for the auditing profession, the PCAOB inspection reports has
for a number of years cited that a number of deficiencies related to auditing FVMs for the
large audit firms. PCAOB stated that they state that a number of the deficiencies cited are
due to overreliance of external valuation firms. By observing how awareness moderates
the relationship between source credibility and professional judgment, this study can
contribute to the efforts of improving judgment quality in areas that are on the top of
PCAOBs concerns list.
39
6.4 Suggestions for future research As like all studies, this research has its limitations. However these limitations can represent
opportunities for future research.
First our study is limited to few variables i.e. source credibility, professional judgment and
awareness. Future research can investigate other factors that can improve judgment quality in
the areas that are on the top of PCAOBs concerns list. One of the areas that PCAOB is
concern with is gathering sufficient evidence, they state that auditors are not obtaining
sufficient evidence to support audits of FVMs. Therefore it could be interesting to investigate
the relationship between planning risk assessments and audit effort.
Also due to the time constraint and the limited resources available, it was not feasible to
access practicing auditors as subjects for the study. Future research can see the effect of using
practicing auditors.
40
References Ashton, R. H. and S. S. Kramer (1980). "Students As Surrogates in Behavioral Accounting
Research: Some Evidence." Journal of Accounting Research 18(1): 1-15.
Baron, R. M. k. D. A. (1986). "The moderator–mediator variable distinction in social
psychological research: Conceptual, strategic, and statistical considerations." Journal of
Personality and Social Psychology Volume 51(6).
Blaskovich, J., & Mintchik, N. (2009, September). Party Of Three? A Source Credibility
Perspective On The Use Of Consultants For Internal Control Assessments. The Journal of
Applied Business Research , 51-68.
Bonner, S. E. (1999). Judgment and Decision-Making Research in Accouting. Accounting
Horizons , 13 (4), 385-398.
BROWN L. S. A. M., SANDRA WALLER SHELTON (2014). "The Effect of Reliance on
Third-Party Specialists under Varying Levels of Internal Control Effectiveness on the Audit
of Fair Value Measurements." Rutgers , The State University of New Jersey.
Chaiken, S., & Maheswaran, D. (1994). euristic processing can bias systematic processing:
Effects of source credibility, argument ambiguity, and task importance on attitude judgment.
Journal of Personality and Social Psychology , 66 (3), 460-473.
Chen, S., Duckworth, K., & Chaiken, S. (1990). Motivated Heuristic and Systematic
Processing. Psychological inquiry , 10 (1), 44-49.
Chevalier, R., Glover , S., Herrman, G., Prawitt, D., & Ranzilla, S. (2013). The KPMG
Professional Judgment Framework. Elevating Professional Judgment in Auditing and
Accounting: The KPMG Professional Judgment Framework , 1-55.
41
Dholakia, R. and B. Sternthal (1977), Highly Credible Sources: Persuasive Facilitators or
Persuasive Liabilities?" Journal of Consumer Research, 3, 223-232.
Eilifsen, A., Messier, J. W., Glover, S. M., & Prawitt, D. F. (2014). Auditing & Assurance
services Third International Edition. Berkshire, United Kingdom: McGraw-Hill.
Glover, S. M., Taylor, M. H., & Wu, Y.-J. (2014). Closing the Gap between Auditor
Performance and Regulators’ Expectations when Auditing Fair Value Measurements:
Evidence from Practicing Audit Partners. 1-46.
Griffith, E. E., J. S. Hammersley, K. Kadous, and D. Young. 2012. Auditing Complex
Estimates: Understanding the Process Used and Problems Encountered, The University of
Georgia, Emory University, 1-47
Hovland, C. I., & Weiss, W. (1951). The Influence of Source Credibility on Communication
Effectiveness. Oxford journals , 635-650.
Kelman, H. C. (1961). PROCESSES OF OPINION CHANGE. Oxford journal .
Kerlinger, F. N. (1973). "Foundations of Behavioral Research." Holt, Rinehart and Winston,
Inc. 3rd Edition.
McKean, K. (1985). Decisions, decisions, decisions. Discover , 22-31.
Mowen, J. C., & Wiener, J. L. (1986). Source Credibility: on the Independent Effects of Trust
and Expertise", in NA - Advances in Consumer Research Volume 13, eds. Richard J. Lutz,
Provo, UT : Association for Consumer Research, Pages: 306-310
Ohanion, R. (1990). Construction and Validation of a scale to Measure Celebrity Endorsers’
Perceived Expertise , Trustworthiness, and Attractiveness. Journal of Advertising .
42
Siddhartha Sankar Saha, M. N. R. (2015). "Impact of Audit Engagement Issues on Statutory
Auditors’ Professional Judgment: An Empirical Analysis." Siddhartha Sankar Saha, Mitrendu
Narayan Roy Volume 6.
Trotman, K. T. (2001). "Design Issues in Audit JDM Experiments." International Journal of
Auditing 5(3): 181-192.
Trotman, K. T., Tan, H. C., & Ang, N. (2011, March). Fifty-year overview of judgment and
decision-making research in accounting. Accounting and Finance , 278-360.
Tversky, A., & Kahneman, D. (1974). Judgment under Uncertainty: Heuristics and Biases.
Science , 185, 1124-1131.
43
Appendix 1: Introduction
Introduction
This study attempts to collect information about differences in individual perception of
source credibility
Procedures
You will be shown a paragraph about a hypothetical company named Paladin Capital Group.
Imagine that you are a part of an auditing team that is conducting preliminary engagement
activities for accepting Paladin Capital Group as a client, during this process your audit team
has determined the fair value measurements (FVMs) to be an area of concern for the current
year’s audit engagement, because there is no market for the exact evaluation of certain
securities held in the portfolio so it needs to be examined carefully. Paladin Capital Group
experienced a significant decrease in the volume of FVMs in recent evaluations. You will in
the next slide be shown information concerning the company´s FVMs
Afterwards you are asked to complete a short questionnaire about the information provided.
The questionnaire consists of a few questions and will take approximately 5 minutes or less.
Confidentiality
All data obtained from participants will be kept confidential and will only be reported in an
aggregate format (by reporting only combined results and never reporting individual ones).
All questionnaires will be concealed, and no one other than then primary investigator will
have access to them. The data collected will be stored for one week and then deleted by the
primary investigator.
44
I have read, understood, and printed a copy of, the above consent form and desire of my own
free will to participate in this study.
Yes
No
Thank you very much for participating in this research study.
Appendix 2: Example of cases
Example for Expert*Awareness Before reviewing the company´s information, here is a summarization of an
inspection report conducted by the Public Company Accounting Oversight
Board According to the Public Company Accounting Oversight Board (PCAOB) there is a dramatic
increase in the number of fair value impairment (FVM) audit deficiencies relating to
impairment testing and the measurement of certain assets, particularly the pricing of
financial instruments.
The increase in audit deficiencies related to FVM and impairment are consistent with a
general increase in all audit deficiencies, and is a likely result of uncertainty created by the
economic downturn. FVM and impairment audit deficiencies are particularly significant
because these two particular issues account for over half of all recent audit deficiencies.
Auditing the estimates and assumptions underlying FVM and impairments requires
heightened professional skepticism as these judgmental areas are susceptible to management
bias, particularly in difficult economic times
45
The PCAOB reports indicated that most FVM audit deficiencies were caused by inadequate
testing of asset prices provided by outside pricing services, and identified a number of
deficiencies related to the auditors’ reliance on evidence from the specialists, including
failure to understand the methods, the models, and the assumptions used by valuation
specialists.
The task:
You are a part of an auditing team that is conducting preliminary engagement activities for
accepting Paladin Capital Group as a client, during this process your audit team has
determined the fair value measurements (FVMs) to be an area of concern for the current
year’s audit engagement, because there is no market for the exact evaluation of certain
securities held in the portfolio so it needs to be examined carefully. Paladin Capital Group
experienced a significant decrease in the volume of FVMs in recent evaluations.
While keeping in mind the preliminary engagement activities & techniques discussed in
MRR 411 (revisjon) , please asses the risk associated with this client after considering the
source of FVMs (fair value measurements).
46
The company:
Paladin Capital Group is a multinational corporation with a multi-stage private equity
division that invests in growing companies. Over last two decades the company has extended
itself to multiple business lines and is now operating in a variety of industries throughout the
world. Company is highly profitable and has a financial segment that manages an investment
portfolio of $ 500 million used to fund operations as needed.
The portfolio represents approximately 15 % of the consolidated total assets, and for the past
years it has consisted of equity securities, investment grade bonds and alternative
investments. Alternative investments consist primarily of collateralized debt obligation (A
structured financial product that pools together cash flow generating assets and repackages
this asset-pool in to discrete tranches that can be sold to investors) securities.
The source:
For securities with an inactive market and where significant inputs are unobservable, Paladin
Capital Group retains the services of a third-party valuation specialist named Primus
Valuations. This specialist has extensive expertise in FVMs with complex Level 2 and 3
securities. Primus Valuations has a strong standing in the industry; and has worked with
Paladin Capital Group for over 10 years. Additionally, the director at Primus Valuations was
a former VP of Finance at Paladin Capital Group and as a result, the specialist is
knowledgeable about the company’s business. Further, senior management at Paladin Capital
Group believes that it is necessary to review evidence used to support the specialist’s FVMs
and relevant assumptions, and challenges the assumptions and inputs when considered
necessary. Accordingly, the company’s manager that is responsible for FVMs and disclosure
communicates with the specialist on a regular basis has a sufficient understanding of the
valuation models, assumptions, and inputs used by Primus Valuations to determine the FVM.
47
On a scale from 1 to 7, where 1 represents low risk, 4 represents moderate risk, and 7
represents high risk. Given your assessment of inherent risk related to fair value
measurement and disclosure.
Did the summarization of the inspection report conducted by the Public Company
Accounting Oversight Board (PCAOB) affect your assessment of inherent risk?
• Yes
• No
In developing fair value measurement and disclosures, Paladin Capital Group uses the
services of an independent third-party valuation firm.
• True
• False
How would you rate the credibility of the third-party valuation firm that Paladin
Capital Group used?
• Very Bad
• Bad
• Poor
• Neither Good nor Bad
• Fair
• Good
• Very Good
48
Appendix 3: Post experimental survey What is your age?
What is your gender?
• Male
• Female
This survey was conducted in English. This made the survey _____ to understand ( fill
in the blank spot)
• Very Difficult
• Difficult
• Somewhat Difficult
• Neutral
• Somewhat Easy
• Easy
• Very Easy
How would you rate your knowledge of FVMs?
• Very Bad
• Bad
• Poor
• Neither Good nor Bad
• Fair
• Good
• Very Good
How much relevant auditing work experience do you have?
• None
• 1-2 years
• 3 or more years
Overall, how do you rate the effort needed to understand and complete the materials?
• Very Difficult
• Difficult
• Somewhat Difficult
49
• Neutral
• Somewhat Easy
• Easy
• Very Easy
Have you ever seen any of these materials prior to completing them today?
• Yes
• No
Did you discuss the materials or your answers with other participants?
• Yes
• No
Thank you once again for participating in this research study.
50
Tables Table 1:
Descriptive Statistics Dependent Variable: Inherent_risk
Source Awareness Mean Std. Deviation N expert off 2.0000 .77460 11
on 3.7500 .62158 12 Total 2.9130 1.12464 23
inhouse off 4.9286 .73005 14 Total 4.9286 .73005 14
Total off 3.6400 1.65529 25 on 3.7500 .62158 12 Total 3.6757 1.39551 37
Table 2:
Levene's Test of Equality of Error Variancesa Dependent Variable: Inherent_risk
F df1 df2 Sig. .031 2 34 .970
Tests the null hypothesis that the error variance of the dependent variable is equal across groups.
a. Design: Intercept + Source + Awareness + Source * Awareness
51
Table 3:
Tests of Between-Subjects Effects Dependent Variable: Inherent_risk
Source
Type III
Sum of
Squares df
Mean Squa
re F Sig.
Partial Eta Squared
Noncent. Paramete
r
Corrected Model
52.930a 2
26.465
52.379
.000 .755
104.759
Intercept
527.777 1
527.777
1044.58
2
.000 .968
1044.582
Source 52.831 1
52.831
104.564
.000 .755
104.564
Awareness
17.576 1 17.57
6 34.7
87 .00
0 .506 34.787
Source * Awareness
.000 0 . . . .000 .000
Error 17.179
34 .505
Total 570.000 37
Corrected Total
70.108 36
Tests of Between-Subjects Effects
Dependent Variable: Inherent_risk Source Observed Powerb Corrected Model 1.000 Intercept 1.000 Source 1.000 Awareness 1.000 Source * Awareness . Error Total Corrected Total
52
Table 4 Correlations
INHOUSE EXPERT INHOUSE Pearson Correlation 1 -.768**
Sig. (2-tailed) .006 N 14 11
EXPERT Pearson Correlation -.768** 1
Sig. (2-tailed) .006 N 11 11
**. Correlation is significant at the 0.01 level (2-tailed).
Table 5: Correlations
EXPER
T EXPERT_AWARENESS
EXPERT Pearson Correlation 1 -.768**
Sig. (2-tailed) .006 N 11 11
EXPERT_AWARENESS
Pearson Correlation -.768** 1
Sig. (2-tailed) .006 N 11 12
**. Correlation is significant at the 0.01 level (2-tailed).
